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Monday, February 9, 2009

Right to steer a forceful course

Feb 9, 2009BUDGET 2009

By Lim Chin

TWENTY-FIVE years ago, Singapore suffered its first recession since its independence in 1965. The causes were traced to the fall of export demand and to the loss of competitiveness owing to an internally generated policy of high wages.

As a consequence, government policy then aimed to restore competitiveness. The measures it adopted included cutting CPF contribution rates. The economy sprang back into positive territory within a year, and the CPF cuts were gradually restored in subsequent years.

The circumstances surrounding the current downturn are very different and therefore require different policy measures. Unlike in 1984, this recession is not due to a loss of competitiveness. It is the result of a severe global financial crisis that has led to global income compression and a fall in external demand. Exports are unlikely to recover until the global economy recovers; and that is unlikely to happen until the United States economy recovers. All this may take some time.

What should Singapore do in the meantime? The 2009 annual Budget sets out four goals. The first is to save jobs. Second is to strengthen the competitiveness of workers and firms; third, to provide income relief to families; and fourth to invest in both the country's physical and social infrastructure.

To achieve these policy aims, Finance Minister Tharman Shanmugaratnam's 2009 Budget contains a $20.5 billion 'Resilience Package'. The five main policy measures are: a Jobs Credit scheme to defray the wage costs of firms; a Special Risk-Sharing Initiative (SRI) to stimulate bank lending; tax relief to enhance business cash-flow and competitiveness; direct assistance to support families; and expenditure on infrastructure.

The last three measures are normal countercyclical measures. What is interesting about this Budget are the first two extraordinary but temporary measures - the Jobs Credit scheme and SRI - and the decision to finance them by dipping into the reserves.

Why extraordinary? If one wants to save jobs, one can think of many other ways of doing so. For instance, corporate tax rebates is one possibility. But small- and medium-enterprises, which account for 60 per cent of jobs in Singapore and do not pay much corporate taxes, would not have been sufficiently incentivised by corporate tax rebates to retain employees.

There are also other possibilities, such as work-share, which has been practised elsewhere, or CPF cuts, which was tried in 1985. Both of these options would make it cheaper for firms to keep workers but the burden would have been borne wholly by workers. Put differently, these options would have had workers pay to save their own jobs. That would not have been a socially desirable outcome, especially since the country has sufficient reserves to absorb the economic shocks. Given the severity of the shocks, it is altogether fitting that the Government decided to seek the President's permission to use some of the reserves.

The Jobs Credit scheme alone would not be sufficient to save jobs if businesses found it difficult to secure bank credit lines even for normal business and trade. Despite the fact that domestic banks were minimally exposed to the US sub-prime mortgage-backed-securities at the heart of this crisis, banks here are exercising extreme caution. The entry of the Government as a co-lender to share risks with risk-averse banks should help them to start lending again. This is an innovative move and also an extraordinary one as it is to be financed from the reserves.

Both the Jobs Credit scheme and SRI are temporary measures that are not part of the longer-term Budget. As the economy recovers, banks would not need the SRI to extend loans and the Jobs Credit scheme can be withdrawn to avoid any potential discomfort among our trading partners.

Overall, the Resilience Package has weighed heavily on supply side measures. But it would not have been complete without initiatives to stimulate aggregate demand. Measures to provide direct assistance to families ($2.6 billion) and expenditure on infrastructure ($4.4 billion) are among the steps being taken to stimulate aggregate demand.

The latter is government investment expenditure that will lift the economy now as well as provide a capital base for the future. And the former will provide some relief to those who need it most at this point and thus provide a small stimulus to consumption.

Some have argued that more could have been done to stimulate the economy - by reducing the Goods and Services Tax across the board, say, or by means of giving out higher personal income tax rebates. I would argue that neither measure would have provided an effective stimulus because of Singapore's high marginal propensity to import and to save, especially among the higher income groups. Such consumption stimulus would have had a small multiplier effect on the economy or a small bang-for-the buck.

In sum, this Budget is well designed. The size of the stimulus package exceeds expectations and the Jobs Credit and SRI initiatives are quite innovative. And using the reserves at this juncture to finance these initiatives is entirely appropriate.